Reportedly, Merkel is to side with Schäuble in her meeting with Sarko on Friday. Why do you think she changed her mind? I haven't seen any news about her voicing an opinion on this, so there was the Bundesbank boss only – which could have been interpreted as either channelling Merkel's disagreement with Schäuble or, quite the opposite, trying to overcome the fact of being a political nominee and establish credibility with the in-house hawks by demonstrating independence from the government. But with this latest I now think Merkel didn't made up her mind and then chose whatever furthers her stay in power.

Meanwhile, the chairman of the SPD (PES!) called Schäuble's plans a placebo and dared something bolder in calling for defaults and Eurobonds.

Let's not forget Bundesbank chief Jens Weidmann was Merkel's economic advisor until she chose him to succeed Axel Weber earlier this year. So, we can either assume they were on the same page on no bondholder bailouts until 2013 or, more cynically, as you say, that Merkel has no position of her own and just does what is personally politically expedient hoping nobody calls her out on her change of opinion.

"Voluntary early rollover" means I hold a Greek bond and the Greek government sells me a new bond, the proceeds of which they use to buy the old bond.

Whether or not this involves a loss for me or is done "at par", I fail to comprehend how this could constitute a "credit event" in the eyes of anyone.

Now, if people perceive the I bought the new bond under duress, maybe they'll call it a default, but they don't have a legal leg to stand on.

This can also be done as a bond swap. I swap my existing bond for a newly issue bond, and I agree with Greece that the bond is worth the same as the old one. Mark-to-market and hold-to-maturity accounting issues galore, as you can imagine. Credit rating agencies have said they would interpret most bond swaps as a credit event. But if you structured it as two bond purchases as above, it wouldn't be.

A "maturity extension" can be seen as a bond swap. I exchange a bond maturing in 5 years for a bond maturing in 10 years. For the same book value, the 10-year bond would have smaller periodic payments, improving Greece's ability to pay. Longer maturities have higher sensitivities to interest rates higher downside risk, and might lose market value quickly. If the maturity extension is at a loss, it would be a credit event if "involuntary", yatta yatta bing bing.

These are all examples of "debt restructurings".

A "default" is a failure to meet obligations as they mature. Evidently, if restructurings are "voluntary" there's no "default".

This has nothing to do with mathematical finance and everything to do with law and politics, evidently, though faulty accounting principles help obfuscate the issues. As does jargon.

"Bondholder bail-in" means forcing bondholders to realise losses on their bond portfolios. A "bond rollover" or "bond swap" or "maturity extension" or "debt restructuring" is a "bail-in" if it involves a loss for the bondholder.

On second thought, I may have been confused: I was interpreting "bondholder bailout" as bailing out private holders of Greek bonds in case of a Greek default, while you probably meant bondholders participating in Greece's bailout... financial terms are difficult.

Within the term of the EFSF, no way can we now - I want say this very clearly once more, because it is often misunderstood - introduce a mandatory participation of private creditors, which there won't be until 2013.

My emphasis. Schäuble's proposal is supposed to be voluntary, while the opponents argue that rating agencies won't see it as voluntary...

(2) The euro-area Member States undertake that they shall liquidate EFSF in accordance with its Articles of Association on the earliest date after 30 June 2013 on which there are no longer Loans outstanding to a euro-area Member State and all Funding Instruments issued by EFSF and any reimbursement amounts due to Guarantors have been repaid in full.

I said agai and again that the funds we created to save the euro - both for Greece as well as for the aggregate euro rescue package - which expire in 2013, can in no case be just extended. That is why already today, one has to prepare and think about what we will be doing then. We agree that we need a rescue mechanism that is designed to be durable and qualitatively different. I think it's a very good signal that Germany and France have said jointly: for that, we need a treaty amendment, and this treaty amendment includes a mechanism in which the creditors, too, will participate financially in the solution of a difficult situation for the euro. This is a big step forward.

I failed to find the actual Deauville Declaration on the government site, but here is a copy of the German version, and here is the French Presidential office's English translation. The relevant part:

The amendment of the Treaties will be restricted to the following issues:

* The establishment of a permanent and robust framework to ensure orderly crisis management in the future, providing the necessary arrangements for an adequate participation of private creditors and allowing Member States to take appropriate coordinated measures to safeguard financial stability of the Euro area as a whole.

On the German government site, there is a copy of an op-ed for Handelsblatt by an advisor of the financial ministry (Schäuble), which comments the issue thusly:

Crucial to curbing the national debt is the participation of creditors in the costs of rehabilitating over-indebted countries, that is a working process for state insolvencies. The insolvency relates only to the servicing of public debt, not to other government activities, and does not include the selling off of state assets. That is, this is about something different from a private bankruptcy.

If such a process is reached, the EU sanctions against debt sinners are expendable if necessary. Countries threatened with over-indeptedness will be required to pay high interest rate surcharges earlier than previously and lose access to further loans. Exactly at this point is the statement of Merkel and Sarkozy going far beyond what the Van Rompuy Task Force has proposed. While the Task Force did not even mention creditor participation, it is now foreseen to introduce such a procedure as part of a treaty amendment...

Now the decisive issue is the way and method of the combination of the bankruptcy process and bailouts. Of foremost importance is the order. The participation of the creditor must appear at the beginning. This participation takes place mainly in the form of a "haircut", i.e. a sweeping reduction of claims. Only then can the country receive assistance. Under no circumstances may the aids be granted beforehand. Otherwise the danger exists that it will never come to the involvement of the private creditors and in the end the tax payers will pay the price of the rehabilitation.

This was not merely about early rollover but participation in a default, and an apparently mandatory one. So I would conclude that Merkel's March 2011 comments were probably motivated by the financial sphere's negative reaction to the Deauville proposal, saying "don't be scared, me and Sarko only proposed this for after 2013".

So I would conclude that Merkel's March 2011 comments were probably motivated by the financial sphere's negative reaction to the Deauville proposal, saying "don't be scared, me and Sarko only proposed this for after 2013".

Germany's Angela Merkel, by contrast, pushed ahead with her plan to set in concrete the principle that government bondholders should be prepared post-2013 to suffer losses if a government can't pay its bills. She got her way and EU governments this month backed the principle as part of a future financial-rescue regime. Do note, however, that even conservative Angela Merkel kicked the can down the road a couple of years like any run of the mill politician is likely to do.

Even so, Ms. Merkel's decision to be explicit about the possibility of future bondholder losses spooked the markets. There, a little more ambiguity might have been a good thing. Usually markets tend to like certainty but it is apparent that bondholders of sovereign debt dislike the certainty that in the future they will have to share in losses due to governments having a solvency problem and restructuring, really defaulting, on government bonds.

Of course, if you tell the markets you'll allow defaults after 2013, you won't be able to place any bonds in the open market with maturities after 2013...

Merkel's position since October has been no losses for private bondholders before 2013

For October, that's interpretation, for March, it's explicit. (And before Merkel and Sarko brought that proposal in, there was no one proposing it for any time including after the ESFS, either.)

Either way, there is no contradiction between the Schäuble proposal and either the Deauville Declaration or Merkel's March 2011 promise that I can see, and all of them seem motivated by appeasing the don't-spend-our-precious-tax-euros members of the own camp.

A purely voluntary maintenance of exposure at current market rates would make the sovereign's debt even more unsustainable and, in time, will ensure a default on the new bonds. The only way to prevent the coupon/yield on the new bonds from being close to market rates and thus unsustainable would be to provide the new bonds with seniority or some collateral; but both options are undesirable as a rollover is not a case of "debtor-in-possession" financing and thus doesn't justify such credit sweeteners.

If, instead the rollover occurs at original coupon or well below market rates, so as to provide Greece with some debt relief, the rollover option is not purely voluntary and has coercive elements; thus, it is not different in any substantial way from the orderly debt restructuring, or reprofiling, that the ECB and other official sector folks so vehemently oppose.

It is rightly acknowledged that people of faith have no monopoly of virtue
- Queen Elizabeth II

German banks have sold off enough of their Greek bonds that they are now at a manageable level; French banks have held on to theirs (or own Greek subsidiaries which hold the bonds).

So a rollover/default is something the German banks can live with, given that they have already imposed themselves a haircut. But the French banks/government are still in denial, and are soon to hit a brick wall.

Unless there is a change in ECB policy, or something.

It is rightly acknowledged that people of faith have no monopoly of virtue
- Queen Elizabeth II

Another possibility is that the French banks understand that they will get cents on their  from Greece, but want their Spanish and Portuguese bonds to mature and be rolled over before Greece makes an unequivocal demonstration to Spain and Portugal that default is not the end of the world. But that's data-free speculation on my part.

The part about French banks I don't get is why bonds to own subsidiaries are to be considered as a risk equivalent to that faced by foreign banks holding sovereign bonds. Can't companies be much more flexible about rollovers and even haircuts in that case?

Regarding the ECB, what is your thinking about that 50 billion exposure? Could a default on that mean, as argued, an actual (or at least perceived) risk to the ECB itself? (Where I am not even sure whether that is supposed to be a liquidity, solvency, credibility, or some other crisis.)

Regarding the ECB, what is your thinking about that 50 billion exposure? Could a default on that mean, as argued, an actual (or at least perceived) risk to the ECB itself? (Where I am not even sure whether that is supposed to be a liquidity, solvency, credibility, or some other crisis.)

In CEPR Policy Insight No.24, Willem Buiter asks: Does it matter if a central bank suffers a large capital loss? Can the central bank become insolvent? How and by whom should the central bank be recapitalised, should its capital be deemed insufficient?

Insolvency for central banks therefore would mean failure to pay obligations as they fall due (equitable insolvency) rather than liabilities exceeding assets (balance sheet insolvency).

As long as central banks don't have significant foreign exchange-denominated liabilities or index-linked liabilities, it will always be possible for the central bank to ensure its solvency though monetary issuance (seigniorage).

...which the ECB won't do, leaving recapitalisation by the Treasuries of the 15 Eurozone governments, which is tricky. Did I miss something?

The European Central Bank (ECB) has decided to increase its subscribed capital by 5 billion, from 5.76 billion to 10.76 billion, with effect from 29 December 2010. This decision was taken by the Governing Council of the ECB in accordance with the Statute of the European System of Central Banks and the ECB, as well as the Council Regulation No 1009/2000 of 8 May 2000 that foresees an increase in the capital of the ECB by up to this amount.

This decision resulted from an assessment of the adequacy of statutory capital conducted in 2009. The capital increase was deemed appropriate in view of increased volatility in foreign exchange rates, interest rates and gold prices as well as credit risk. As the maximum size of the ECB's provisions and reserves is equal to the level of its paid-up capital, this decision will allow the Governing Council to augment the provision by an amount equivalent to the capital increase, starting with the allocation of part of this year's profits. From a longer-term perspective, the increase in capital - the first general one in 12 years - is also motivated by the need to provide an adequate capital base in a financial system that has grown considerably.

In order to smooth the transfer of capital to the ECB, the Governing Council decided that the euro area national central banks (NCBs) should pay their additional capital contributions of 3,489,575,000 in three equal annual instalments. Consequently, the current euro area NCBs will pay 1,163,191,667 as their first instalment on 29 December 2010. The remaining two instalments will be paid at the end of 2011 and 2012, respectively. Moreover, the minimal percentage of the subscribed capital, which the non-euro area NCBs are required to pay as a contribution to the operating costs of the ECB, will be reduced from 7.00% to 3.75%. The non-euro area NCBs consequently will make only minor adjustments to their capital shares, which will result in payments totalling 84,220 on 29 December 2010.

Then, each national treasury will have to recapitalize its own National Central Bank, with "no fiscal transfers".

So, the problem is not whether or not the ECB will become insolvent. The question is whether the ECB will allow Eurosystem member National Central Banks to become insolvent.

ECB council members have used the threat of insolvency of the Irish and Greek central banks explicitly over the past year.